Friday, August 31, 2007

German Consumer Confidence August 2007

Consumer confidence in Europe's largest economy, Germany,dropped for the first time in six months at the end of August, according to Gfk's confidence index for September, which is based on a survey of about 2,000 people. The consumer climate index projected for September fell to 7.6 from 8.5 in August.

The economic outlook sub-index also fell to 48.4 from 64.8, while the income expectations sub-index dropped to 9.2 from 27.9. There was also a decline registered in households' willingness to spend, with that sub-index dropping to 6.4 from 9. To get some idea of where we are, here is the complete index for the last 12 months. As we can readily see, during the last three months nothing has been trending upwards, and the economic outlook and income expectations components have been moving notably down.

Now if we look at the individual components we can get a clearer picture. Firstly the consumer climate:

Really this is not so bad as might have been expected, the climate was much worse back in January and February, just after the 3% increase in VAT. Confidence subsequently picked up, but it may well now have turned again.

If we look at the economic outlook sub index, this seems to have peaked back in May-June, and be now trending down in a way which conforms to the picture we have been getting from the GDP data.

The consumer propensity to spend sub index also makes interesting reading. We can see a marked propensity to spend in the last months of 2006, and then a sudden drop at the start of 2007. The VAT rise is evident. What is also evident is that the effect of the VAT rise has not worn off, as many suggested it would. The 3% increase in costs is still there, and remains there, and the impact will continue. Conclusion, increasing consumption taxes is NOT a way to pay for the health and pension costs associated with an ageing society. It is simply counterproductive, as we are now about to see, I fear.

Finally lets take a look at the income expectations sub-index. This is perhaps the most interesting one of all. Now many of you may remember that early this year there was a lot of talk in the press, and over at the ECB, about how German wages and salaries would start to rise as unemployment dropped and the recovery gathered pace. This was one of the reasons behind the "strong vigilance" expression in the ECB statements. Well if you look at the expectations index you will see that from March to June many people in Germany seemed to believe this story, despite the fact that wages have actually been pretty flat. But as we can see, reality is sinking in, and the German wage earner no longer believes the Goldilocks recovery story, which is one of the main reasons I don't either see this trend as a knock-on effect of sub-prime scandals or as simply a short term blip, but rather I think it forms part of the normal course of events we have become so used to in the German economy context.

As I say in this post, perhaps it is about time that people started to adjust their 2007 German GDP forecasts, to take into account the evident underlying reality there.

Thursday, August 30, 2007

Italy Retail Sales June 2007

Here is the latest data on Italian retail sales from (June) ISTAT:

L’Istituto nazionale di statistica comunica che nel mese di giugno 2007 l'indice generale del valore delle vendite del commercio fisso al dettaglio, con base 2000=100, è risultato pari a 108,0 con un aumento dello 0,7 per cento rispetto allo stesso mese dell’anno precedente.

Or as Bloomberg put it:

Italy's economy, the fourth-biggest in Europe, grew at the slowest pace in 1 1/2 years in the second quarter as manufacturing output cooled. This month's rout in financial markets caused by the U.S. subprime crisis that raised the cost of loans has darkened growth prospects. The Italian economy is unlikely to expand at the 2 percent previously forecast, the government said this week.

Actually Bloomberg also collaborate with NTC economics to produce a monthly index based on a survey of more than 1,000 executives. This data is rather more up to date than that produced by ISTAT, but the picture offered is pretty similar, and August was the sixth month in a row that the index gave a reading below 50, a level which indicates contraction.

Again, as Bloomberg put it:

A seasonally adjusted index of retail sales was at 47.8 in August compared with 46.1 in July, according to a survey of 440 retail executives compiled for Bloomberg LP by NTC Economics Ltd. The reading has stayed below 50, the level that signals a contraction in sales, since February. Market turmoil aside, Italy is suffering on other fronts. Tourism, a key contributor to Italian retail sales in the hot summer months, has been ``weaker'' in August, typically a boom month for consumer spending, NTC panelists reported. Twenty-eight percent of retailers surveyed said they missed their sales targets this month, with only 16 percent reporting they beat their expectations. Looking ahead, 21 percent expect to beat their September targets.

Italy Consumer Confidence August 2007

ISAE have today published their August 2007 reading for the Italian consumer confidence index (pdf). Bloomberg summarises:

Italian consumer confidence dropped to a 16-month low of 106.5, a separate report showed today. Household spending makes up for two-thirds of the $1.8 trillion economy and is the motor for growth in Italy, the laggard among the top four economies in Europe.

If we look at a graph of the time series we will see that this index peaked back in December, and has been steadily working its way down since, which isn't really surprising when you come to look at the general macro data for the Italian economy so far this year.

Tuesday, August 28, 2007

IFO Business Confidence Index August 2007

Well the latest edition of the Ifo Index is now out.

It seems German business confidence fell to a 10-month low in August. The Munich-based Ifo research institute's sentiment index, based on responses from 7,000 executives, declined to 105.8 from 106.4 in July. The Ifo decline was led by a drop in the Business Expectations outlook for the coming six months, with the index falling to 100.4 from 101.7. The effect of this was cushioned by a slight gain in the assessment of current conditions index which rose to 111.5 from 111.3. This was the first increase in four months.

Padoa-Schioppa and the Italian 2007 GDP Growth Forecast

Italian Finance Minister Tommaso Padoa-Schioppa is being quoted in the press this morning as saying that ``The growth target of 2 percent for 2007 appears to be more ambitious that we thought two months ago,''.

He certainly has this one right. With growth in Q1 at just 0.3% and in Q2 at 0.1%, and the eurozone economy visibly slowing by the day, I would say it will be hard this year for Italian GDP to push through the 1% ceiling as an annual total. Basically I don't see combined growth in Q3 and Q4 as being greater than the combined total for Q1 and Q2. I explain some of my reasoning here.

This is why I normally don't agree with the kind of economists Bloomberg seems to consult, who seem to continually regard Italy's consistently sub-par growth readings as "unexpected". If you look at Italy's growth history over the last 15 years, think about the ageing population issue, and follow the short term economic data on consumer confidence, retail sales and industrial ouput, then the GDP readings being obtained shouldn't come as a shock, since they are empirically and theoretically entirely to be expected. As a consequence the annual growth rate for 2007 looks like being well down. To be talking about 2% growth at this stage is frankly ridiculous. As I say, in the current climate it is hard to imagine H2 2007 being better than H1. So I think someone somewhere had better get to work preparing the explanations for those good people from Standard and Poor's and Moody's.

Thursday, August 23, 2007

German Q2 2007 GDP Under The Microscope

The German Federal Statistics Office published the detailed breakdown of the Q2 2007 GDP data this morning. Really there were no surprises, and growth was as previously announced (August 14) at 0.3 percent slowing from 0.5 percent in the first quarter. This means that German GDP has grown at 0.8% so far this year, and if this performance was simply repeated in the second half German growth would be around 1.6% for 2007. But the German economy is slowing notably (see below), so they will be lucky to see 1.5% growth for whole year 2007, and downside risks abound so the final number may be considerably below this. Let's take a look at why.

First off quarterly German growth since Q1 2006 (Eurostat data):

As can be seen the German economy has now been slowing since Q4 2006, and if we treat Q4 2006 (due to the pre VAT rise burst in activity) as something of an anomaly, then we can see a steady decline since Q2 2006. In the present global environment my opinion is that this trend is unlikely to be reversed.

There are a number of reasons for this, as explained extensively in this post (and this one) the German economy is essentially structurally dependent on exports for growth. So lets look at what has been happening to German export performance in recent months:

As we can see the level of German exports has been virtually stationary since February 2007. Now if we look at the % change month-on-month:

Again it is clear that the rate of increase in German exports has been slowing steadily since September/October 2006, but that again the stationary level since at least February 2007 is pretty clear.

Now if we move to construction activity:

Again a similar picture emerges, with the pronounced slowdown since February being evident. This is even clearer if we look at percentage changes month on month:

Since February activity has declined in 3 of the 4 months, whilst in the other month (May) it was virtually stationary.

What can we conclude from all this. Well, if we take into account that domestic private consumption in Germany is virtually flat (and domestic public consumption is constrained by the need to reduce the deficit) we can see that at the present time German GDP is being virtually exclusively pulled by fixed capital investment. The time series for retail sales will give some idea of what has been happening to domestic consumption:

This pattern should by now be not entirely unfamiliar, which leaves us as I say, almost exclusively with fixed capital investment to pull the train, and this gives additional significance to the ZEW Economic Sentiment index published earlier this week. Basically it is hard to see investment remaining buoyant in this climate. So, the bottom line is, that downside risks abound, and on my forecast, German GDP will be struggling hard to break the 1.5% annual threshhold for 2007.

Tuesday, August 21, 2007

Q2 GDP Data from The Eurozone

by Claus Vistesen

Cross posted from Alpha Sources

In keeping with tradition and also because I have only recently returned from holiday I am coming in on the heels of Sebastian Dullien from Eurozone Watch and Morgan Stanley's Elga Bartsch in my assessment of the big events in the Eurozone economy. In this case the Q2 GDP figures are up for scrutiny and relative to Sebastian's and Elga's fine reviews I provide some graphical displays too. As I have already noted briefly in my previous note the numbers came out largely as I had expected in the sense that we are now looking at a marked slowdown. For a complete overview of the aggregate Eurozone GDP performance over the last four quarters the graph below plots the relevant data.

As we can see the Eurozone has steadily slowed from a stellar performance in Q4 2006 to a much more meager performance in Q2 2007 as with a quarterly growth rate at only 0.3% on the back of 0.6/0.7% (depending on statistical measurements) in Q1 2007. In this light and even though I had indeed expected an aggregate slowdown 0.3% seems a bit stark and on that note I do expect the quarterly figures for Q3 2007 to improve but only slightly. Another possibility would be for the current GDP estimate to be adjusted upwards at a later stage. In any case a large part of the hefty decline in Q2 GDP comes from the negative contribution from industrial production which we might expect to pick up slightly in the current quarter as noted by Sebastian (linked above) However, what does seem to be certain is that the consensus forecasts for annual GDP growth seems to stand before a significant downward correction in line with my overall and relative bearish outlook on the Eurozone based solidly on an analysis of real economic fundamentals. Turning to the individual countries an an assessment of the big four in the Eurozone especially poor Italy was a drag on Eurozone growth and it is looking more and more as if we are moving into some very uneasy territory towards the end of 2007 with Italy's large public debt and over the year budget deficit. This is especially the case as the debacle in the credit markets seem set to continue which is sure to put considerable downside risk to real economic fundamentals. In this light the recent comments from Italy's Finance Minister Tommaso Padoa-Schioppa that Italy would not raise capital through government debt to put a floor under what seems to a pretty hefty slowdown. Of course, the Finance Minister was explicitly referring to the potential adverse effects from the mess in credit markets but at this point this must be considered proxy for a much wider ranging issue and just what will happen to Italy's sovereign debt rating if growth does not pick up. Returning to the actual data in the membership countries we can see that all the big countries posted a somewhat decline in Q2.

In Spain growth slowed to below 1% quarterly growth which is still though considerably above the other big member countries. Apart from Italy's poor performance also Germany posted a disappointing 0.3% GDP growth rate and more worryingly as also noted by Sebastian Dullien (linked above) especially German domestic demand seems stubbornly reluctant to really take off. This does not come as unexpected news I think and as I have argued several times we need to look at the structural characteristics of Germany's ageing population to understand why domestic demand in any sense won't be able to pull forward the economy. More generally in the case of Germany we also need to look at the destination of German exports and especially the destination of the growth of German exports which increasingly is reliant of the CEE economies and Russia. As such and since the CEE economies are perhaps set to become very interesting as we move further into 2007 the growth platform in the Eurozone is becoming shaky indeed. Lastly on Germany we also have the recent ZEW business confidence measure which demonstrates a clear feedback mechanism from the recent turmoil in financial markets. So what we seem to have on our hands here is an already present slowdown which is exacerbated by the wobbles in financial markets.

Turning to France we also note a disappointing trend and in fact over the last four quarters it is the worst performers amongst the Eurozone countries. I will however expect France to outperform Italy somewhat over the course of the next quarters. The last thing I want to show are two graphs of recent monthly inflation measures which after all is the ECB's weapon of choice (apart from the M3) in setting interest policy relative to the gauges of real economic fundamentals. As we can see the first half of 2007 have been marked by a significant uptick of inflation which in this case is measured by the HICP index (index 100 = 2005).

Note in particular the u-shaped curve for energy prices which suggest that headline inflation pressures are returning after a dip in the latter part of 2006. Expressed in percentages the inflation rate for July was 1.8% down from 1.9% in June as reported by Eurostat. However as the FT also notes the recent monhtly dip masks the fact that core prices held steady which suggests that future inflation is in the pipeline (apart from headline inflation) as we venture through the last part of 2007. As I have also noted before this puts the ECB in a difficult spot note least because the credit market turmoil also loom ever more so in the background. The main issues rests on the ECB's vigilance against inflation which is of course well established relative to the downside risk of a continuation of the deterioration of the economic fundamentals as well as the potential disturbing effects from wobbly financial markets.


The second quarter GDP figures from the Eurozone came out largely below the consensus forecast and coupled with the recent and apparently sustained bout of market wobbles the outlook for the Eurozone economy seems to coming in line with the general out of consensus bearish analysis voiced here at Alpha.Sources. At this point the next interesting obviously centers around the probability of a hike by the ECB come September. Given the recent comments coming out of Frankfurt you would expect 4.25% to be a done deal and indeed judged by inflation pressures there seems to be ground for a hike. However, at this point other issues are of course entering the big equation and beyond what seems to be a clear deterioration of economic fundamentals. At this point it is difficult to see what the major central banks will do in the midst of the current financial debacle regarding short term interest rates. A big test will come Thursday when the BOJ decides whether to push forward. I have argued that this is unlikely for other reasons than the current credit/liquidity crunch but it will be interesting to see what the discourse will be. The ECB will be facing a similar issue in so far as how to incorporate the financial market situation into the general assessment. Clearly, the probability of a hike has gone down both with the current GDP figures as well as the financial market situation but I maintain my view that the ECB will take it to 4.25% which will be held for the remainder of 2007. An obvious downside to this call is of course whether the central banks need to step up their role as lenders of last resort as well as perhaps twig short term interest rates in what could only be interpreted as emergency moves. At this point, I think this is unlikely but the risk is clearly there.

German ZEW Economic Sentiment Index Slips Significantly

German investor confidence took a tumble this month in the wake of the crisis in the US subprime mortgage market and slowing growth in the Eurozone economies. The Mannheim-based ZEW Institute’s “economic sentiment” indicator fell for the third consecutive month to the lowest level since December last year. At minus 6.9 points, down from 10.4 points in July, the index remains significantly below its historical average.

Claus Vistesen has the story and the analysis here. This graph he produces really says it all:

The Institute places a lot of emphasis on the impact of the subprime situation (which has of course had significant repercussions in the German banking sector), but as the graph below - which comes from Claus Vistesen's post - shows, GDP growth in both Italy and Germany slowed notably in both Q1 and Q2 2007, so in this sense the sentiment index reading is far from surprising.

Having said this, if we take a look at a slightly longer time series on the index - from 2000 - we can see just how low sentiment currently is, how it first fell sharply and continuously across the second half of 2006, only to then rebound slightly at the start of 2007. I think all of this is reasonably explicable in that most observers expected a stonger initial slowdown in Germany as we went into 2007 (the VAT rise and all that) - I certainly did, and I was wrong - but then the sentiment index soon responds to the renewed uptick (just how much has this uptick has got to do with the boom that has been going on in Eastern Europe is a question I find myself asking, since the German economy has clearly been the major beneficiary from this boom), only to then fall back again. But what is also reasonably clear is that this turn in sentiment is not a simple by-product of recent events in financial markets, since the origins of the change of mood stretch back several months. Following the evolution of this index over the coming months is going to make really interesting reading I think.

Sunday, August 12, 2007

Italian GDP Slows in Q2 2007

Economic growth in Italy slowed even further in the second quarter of 2007, according to provisional figures released on Friday by the National Statistics Institute ISTAT. In the April-June quarter gross domestic product increased by only 0.1 per cent, compared with the first quarter of 2007, when GDP grew by 0.3 per cent (see chart below). This is the slowest growth in the last 18 months. Projected growth for 2007 has so far declined from 2.3 per cent based on the first quarter, to only 1.8 per cent at present. This number, apart from being far below the current European Union average of 2.6%, now looks like it may well need further downward revision.

The projections are now also significantly below the estimated 2 per cent growth for 2007 which the government used as a basis for its economic and financial planning document in June. The blueprint envisaged cutting budget deficits, as well as a gradual reduction of the national debt from the current 107 per cent of GDP to 100 per cent of GDP by 2010. Less growth will inevitably result in a smaller increase in revenue, and run the risk of yet more problems with the debt rating agencies.

As the Financial Times says:

If this trend continues, it could create serious difficulties for the centre-left coalition led by Romano Prodi, the prime minister, for whom economic rigour, growth and a reduction of the huge national debt are primary goals.

In general the picture has been becoming reasonably clear from the industrial output numbers we have been seeing, the retail sales data, as well as the consumer confidence readings.

If we look at the chart below which shows year-on-year GDP growth rates by quarter, then it is really starting to look like this cycle may have peaked in the last quarter of 2007.

And if we look at the evolution of Italian GDP growth rates it is clear that the situation is not a new one, average growth rates for the Italian economy have been trending down for the last couple of decades, and it is a hopeless form of wishful thinking to imagine that things will change just like that. If the author of this blog is right this whole process is associated with the steading ageing of Italian society, and if it is then the issue will just not go away, and there will be some explaining to be done to the ratings agencies about just why it was thought to be convenient only two weeks ago, to slow down the implementation of the retirement age reform.

Friday, August 10, 2007

French Industrial Output June 2007

Hard to know how to read this latest data from France. Obviously someone somewhere is feeling the pressure:

Industrial production in France, Europe's third-largest economy, unexpectedly fell in June, led by declines in the output of cars and consumer goods.

Production at factories, utilities and mines dropped a seasonally adjusted 0.5 percent from May, when it rose a revised 0.5 percent, Insee, the national statistics office, said today in Paris. Economists expected a gain of 0.4 percent in June. For the second quarter, industrial output fell 0.3 percent from the prior three months and was unchanged from a year earlier.

Higher interest rates and increased energy prices are weighing on consumer confidence in France at a time when the euro's advance to a record against the dollar and the yen last month threatens to curb exports. France's economic growth is trailing behind the euro-area average for a third straight year.

Wednesday, August 01, 2007

Germany Part and Full Time Work

Source Bundesbank

According to the Economist

Zeitarbeit, as temporary work is known, accounts for 1% of all jobs, but for perhaps more than half of all those created in the past year. One example of the new breed of employers is time & more, which specialises in health care. It has around 400 people on its books, of whom 300 are nurses; two years ago it had 250. Its founder, Bernd Sydow, who sold his firm to Adecco in April, says that it supplies almost all Berlin's hospitals as well as hospitals in other big cities. Around three-fifths of time & more's nurses are called on for stints of one to three days, often at short notice. Having reduced permanent staffing levels and carrying no reserves, hospitals turn to the agency as their requirements fluctuate. Mr Sydow reckons that eventually about 5% of his clients' nurses will come from an external pool.

Agencies such as Mr Lüngen's, in contrast, do not employ those for whom they find work, as Zeitarbeit firms do, but act as brokers. Last year such firms filled 62,000 jobs in the primary labour market, three times as many as in 2002. As well as running his own agency, Mr Lüngen runs his industry's biggest trade association (there are a handful), whose membership has risen from 23 when it was founded in November 2003 to more than 200.

Regulatory reforms explain only part of the change in the labour market. As companies have come under more pressure, workers' pay has been squeezed: as higher returns on capital have been demanded, the relative price of labour has had to fall. That managers can threaten to move work to central Europe or even farther away has strengthened capital's hand. As a consequence, while company profits have risen steeply, workers have done much less well. In the past six years, the share of wages in national income has fallen from around 60% to little more than 55%.

In part, this has come about through a loosening of Germany's system of industry-wide wage deals between employers' representatives and trade unions. This corsetry was never quite as rigid as it looked: variations on centrally struck wage deals at local level and in individual companies were already part and parcel of it.

However, agreements have become more flexible, notably since 2004. Martin Leutz, a spokesman for Gesamtmetall, the engineering employers' federation, refers to a “huge breakthrough” in that year's wage round, allowing companies to deviate from agreed terms on pay, bonuses and hours if this would secure or create employment, or keep investment in Germany that would otherwise go elsewhere—albeit with the agreement of workers' representatives. More and more companies, especially in eastern Germany, have chosen to bypass the central system altogether.

Moreover, negotiated settlements have been modest. Actual pay rises, indeed, have lagged behind inflation for several years. This year it looked as if labour might at last regain some of its old bargaining power, at least in the metal industries. IG Metall, the country's biggest union, demanded a 6.5% rise from the end of April. When Gesamtmetall said no, the union called short warning strikes.

The eventual settlement, reached in early May, covers 19 months, promising 3.9% in the first year and a further 2.1% in 2008, which can be postponed for up to four months. The average annual cost for the duration, according to Gesamtmetall, is 3.3%. That was the unions' best result for several years. With inflation at 1.9% it amounts to a real increase. But not a big one; and the metal industry has been doing particularly well, with export demand riding high. Workers elsewhere are unlikely to see their pay rise by as much.

Bundesbank On German Labour Market

An analysis restricted to the number of persons in work is of no more than limited informative value, however. For example, the relatively favourable growth in per capita employment in Germany is due exclusively to what was – even in international terms – a sharp increase in jobs with reduced working hours, in particular, the expansion of “minijobs” in two surges from 1997 to 1999 and from 2003 to 2004. This idiosyncratic effect is also reflected in the average annual working hours of part-time workers, which has been falling in Germany over the past few years and is now clearly below the euro-area average. Furthermore, there has been a comparatively strong increase in the percentage of part-time workers who would actually prefer longer paid working hours.3 In this respect, the sharp increase in jobs with a small number of working hours in Germany points to structural problems in the labour market. The total number of hours worked in the economy as a comprehensive measure of labour utilisation does show a comparatively sharp decline for Germany (-314%) in the period under review. According to OECD estimates, the total number of hours worked in Germany’s European partner countries has, by contrast, increased (ranging from 314% in France to 37% in Ireland). The figure went up by 912% in the USA and as much as 7% in the United Kingdom.

Germany's Employment Connundrum

German unemployment has again fallen this month, and quite significantly:

The Federal Labour Agency said the number of jobseekers was down by a seasonally adjusted 45,000 last month, against economists’ expectations of a 30,000 fall, putting the jobless rate at 9 per cent. Internationally comparable figures calculated by the German statistical office using the more restrictive International Labour Office definition put the rate at 6.3 per cent in May. The new data brought the total fall in unemployment over the past 12 months to 671,000 and well over 1m since the start of the labour market recovery about two years ago. Employment showed an equally healthy picture, with 41,000 jobs created last month.

This is evidently very good news, but how do we interpret this data? Well with some caution I would argue. This is not, however, the normal response. Bertrand Benoit in the FT article linked to above is not atypical in this sense.

Benoit is almost gleeful:

The rapid fall in unemployment, long the most visible symptom of the “German disease”, has also proven wrong the doomsayers who said the country faced a future of growth without job creation.

He does, however, qualify this statement by pointing to Germany's evident structural dependence on exports:

Yet separate releases on Tuesday underscored what economists see as Germany’s vulnerable spot: its dependence on foreign markets.

Retail sales were up just 0.7 per cent in June against expectations of a 1.2 per cent rise. That followed a 2.5 per cent drop in May. Sales in the first half of the year were weaker than in the same period last year.
(See my post on this yesterday.)

As Benoit notes the "dichotomy between anaemic consumption and vigorous exports could spell trouble later this year as German exporters felt the impact from slowing demand in the US and the euro’s rising exchange rate" however, he then goes on to approvingly quote Gilles Moec, a senior economist at Bank of ­America, who says:

“We could see some wobbling in the second half, although we are confident about the six-to-nine-month horizon as we expect consumption to grab the baton from exports in supporting growth.”

So the real issue here is whether we might see anything more than "wobbling" here, and whether there are any reasons to question whether domestic consumption will in find resurrect itself and finally "take up the baton".

Well, in order to try and clarify what exactly is happening, and given a handy pointer by the Economist (who had a fairly useful article on the German labour market here), I went over to the Bundesbank, and started to consult their monthly reports.

What I found in the May 2007 edition was the following:

The situation in the labour market continued to improve at a rapid pace during the first few months of 2007 in the wake of the cyclical upturn. Employment rose once again, and unemployment showed a marked fall. The mild weather conditions also played a part in this favourable development. The number of persons in employment in the first quarter of 2007 rose by a total of 175,000, or 0.4%, to a seasonally adjusted 39.45 million. The year-on-year increase went up to around 570,000, or 1.5%, primarily in the form of employment subject to social security contributions. In particular, enterprises in the labour leasing sector, which accounted for just under half of the growth, stepped up their recruitment of new employees. Preliminary estimates by the Federal Employment Agency indicate that other forms of employment, such as low-paid part-time employment (mini jobs), activities in connection with job creation measures and employment opportunities (one-euro jobs) as well as assisted selfemployment have become less significant. Data on short-time working are not yet available for the first quarter. This form of employment is, however, likely to have increased again somewhat temporarily owing to the introduction of seasonal short-time working benefits in the construction sector. This is suggested in any event by the data for December 2006, according to which almost 30,000 more persons were receiving benefits than in November.

There was a further perceptible decline in the official unemployment figure in the first quarter. At a seasonally adjusted 3.91 million, there were 287,000 fewer persons registered as unemployed than in the final quarter of 2006. The year-on-year decline widened to 820,000 persons. At 9.4%, the seasonally adjusted unemployment rate was 0.6 percentage point down on the quarter. Within the space of a year, the unemployment rate had gone down by a substantial 2.1 percentage points.

However, the decline in unemployment in the first quarter of 2007 is likely to have overstated the cyclical influence and the mediumterm trend somewhat. Both the favourable weather conditions and the introduction of seasonal short-time working benefits are likely to have had a certain mitigating effect. The pick-up in the labour market in the second quarter could therefore be somewhat weaker than usual. At all events, there was barely any further decline in seasonally adjusted unemployment in April and the unemployment rate remained virtually unchanged on the month at 9.2%. It is also important to remember that, for demographic reasons, the labour supply is currently decreasing, which means that the fall in unemployment appears to be greater than the increase in employment. This is also due in part to the fact that the Federal Employment Agency is continuing to adjust the unemployment statistics.


The 2007 pay round began in March with wage agreements in the chemical and construction industries. The metal-working and electrical engineering industries followed in May. Firstly, the negotiating partners in the chemical industry agreed on an increase in basic salaries of 3.6% starting from the second month of the term of the agreement, which runs for a period of 14 months. A flat-rate payment of 370 will be made in the first month, and a supplementary 0.7% of a month’s salary for each of the remaining months of the contract. In the construction industry, the negotiating partners agreed on a 12-month pay settlement with no increase in the first month followed by a 3.1% increase in the standard monthly remuneration. Additionally, monthly one-off payments of 0.4% of a single month’s salary are to be made. Owing to the objections of some regional employers’ federations to the outcome of the negotiations, however, a conciliation process has now been initiated. Moreover, the pay agreement in the construction sector, which has not yet been accepted, does not affect the existing minimum wage agreement, which is still valid until the end of August 2008 and which provides for an increase in wages and salaries of 1% as of 1 July 2007. The special payments negotiated in the chemical and construction industries can be modified or completely cancelled at individual firm level by alternative agreements. Pay in the metal-working and electrical engineering industries is to be increased by 4.1% as of June 2007. This is to be followed by a further increase of 1.7% in June 2008. A one-off payment of 3400 has been agreed for the first two months of the wage agreement, and one-off payments of 0.7% of a month’s salary for the final five months. The scheduled increases and special payments from June 2008 may be deferred by up to four months at the individual firm level. The wage agreements in the major industrial sectors are a reflection of the cyclical improvement in the trade union’s bargaining position resulting from above-average capacity utilisation and ample reserves of orders. It is also a question of giving employees a fair share of the reward for the enterprises’ economic success, which has become possible not least owing to the wage restraint of the past few years. Pay agreements in the craft trades were much more moderate than in industry. A negotiated wage increase of 2.5% was agreed in the motor vehicle trade of the Federal State of North-Rhine Westphalia as well as a one-off payment of 350 for the first month of the 12-month wage agreement. In the electrician’s trade, agreement on a 2.4% wage increase was also reached in North- Rhine Westphalia (effective as of 1 February 2007) after 34 months without a pay rise.

Wages are to be increased by a further 2.2% one year later. Similar agreements were also reached in other wage-bargaining areas. According to the Deutsche Bundesbank’s pay rate statistics, negotiated rates of pay in the first quarter of 2007 were 0.8% up on the year, compared with +1.8% in the final quarter of 2006. The latter figure was primarily attributable to the one-off flat-rate payment for Volkswagen employees to compensate for the increase in weekly working hours. Furthermore, there were one-off payments in the chemical industry and in the metal working industry in the first quarter of 2006, which were not repeated on this scale. Excluding one-off payments, negotiated rates of pay went up by 1.2% in the first quarter of the 2007, compared with 1.6% in the final quarter of 2006, when public sector banks paid a Christmas bonus which compensated for the lack of holiday pay.

Construction Costs

Following the continuous rise in the cost of construction services over the past few years, prices went up by no less than 4.3% in the first quarter of 2007, and the year-on-year rate of increase widened to 7.7%. There were price rises on this scale in virtually all subsectors of construction. This surge in construction prices is attributable to the VAT increase on 1 January 2007 and the sharply increased prices of intermediate goods. Added to this was an exceptionally high level of utilisation of machinery and equipment. Construction industry capacity has been run down in recent years, which means that the increasing recovery in demand for construction work is now encountering a scarcer supply. Furthermore, labour cost pressure, which has been moderate up to now, is likely to intensify somewhat against the backdrop of the recent wage agreement. A rise in construction prices, especially in residential construction, is usually also reflected – with a certain time lag – in the prices of older buildings and housing rents. Nevertheless, the fact that land prices are virtually unchanged is continuing to have a dampening effect.

Consumer Prices: VAT perciptible effect

In the first three months of this year, the rise in consumer prices, at a seasonally adjusted 0.6%, was distinctly sharper than in the preceding months. The year-on-year increase in the national consumer price index (CPI) went up from 1.3% in the fourth quarter of 2006 to 1.7% in the first quarter of 2007. This corresponding figure for the Harmonised Index of Consumer Prices (HICP) was 1.9%, compared with 1.3% at the end of 2006.

One reason for the sharp rise in prices, despite the fact that crude oil cost less on average, was that consumer energy prices rose by 2.3% on the quarter and 2.4% on the year. This was due chiefly to the increase in the standard rate of VAT from 16% to 19%, which took effect on 1 January 2007. The higher level of VAT also had a clear impact on the other components (for more information, see the initial results of a macro data analysis on pages 52-53). The cost of industrial goods (excluding energy and tobacco products) increased by a seasonally adjusted 0.5% in the first quarter of 2007, and the year-on-year figure went up from 0.6% to 1.4%. The effect of VAT on prices in the first quarter of 2007 was particularly marked in the case of motor vehicles; the year-on-year rate of price increase widened from 1.1% to 3.0%. There was an interruption in the downward price trend for household appliances. The cost of services (excluding housing rents) increased by a seasonally adjusted 0.8% on the quarter. The corresponding year-on-year rate doubled to 2%, a part in this also being played by the increase in insurance tax from 16% to 19%. As a consequence, insurance premiums were up by an average of 2.6% on the year. Significant VAT effects were apparent in the prices of hairdressing and motor vehicle repairs, for example.

In assessing the overall impact of the VAT increase, there arises the problem that price adjustments are made for other reasons as well at the same time. Therefore, the “normal” price rise excluding VAT has to be deducted from the overall price increase. In the case of the two subcomponents of goods (excluding energy and tobacco) and services (excluding housing rents), it may largely be assumed that the price trend excluding VAT would have been much the same as in the previous two years. In the absence of more detailed information, it would appear reasonable to assume that, in the case of energy, the VAT increase was passed on in full. According to this calculation, the higher rate of VAT contributed around 0.6 percentage point to the quarter-on-quarter rate of increase in the national consumer price index (CPI) and just under 0.8 percentage point to the HICP increase. 2 This increase came on top of advance price adjustments last year, such as the increase in tobacco prices of just under 5% in October. There were also indications of accelerated price adjustments in the case of other goods, such as cosmetics and clothing. If these anticipatory effects are added to the price effects in the first quarter of 2007, the overall contribution of the higher rate of VAT to the year-on-year CPI increase is roughly 1 percentage point.3 The figure is likely to be somewhat higher for the HICP. The price effect of the VAT increase was thus considerable, but smaller than the mathematical effect of a direct full pass-through of 1.4 percentage points to the CPI and 1.6 percentage points to the HICP. Two factors need to be taken into consideration in this context. One is that a reduction in social security contributions in January 2007 provided relief to enterprises. The other is that it may be assumed that there will be further lagged VAT-induced price adjustments in the course of 2007.